Introduction to Company Accounts-Redemption of Preference Shares – CS Foundation Fundamentals of Accounting Notes

Go through this Introduction to Company Accounts-Redemption of Preference Shares – CS Foundation Fundamentals of Accounting and Auditing Notes will help students in revising the entire subject quickly.

Meaning:

  • it refers to the process of repaying an obligation, at amounts and timings that are pre decided.
  • Redemption date means the maturity date.
  • Company adjusts its financial structure through the process of redemption.

Purpose of Issuing Redeemable Preference Shares:

  • Provides a proper way of raising finance.
  • Encourages the potential investors to buy redeemable shares
  • Redeemed out of surplus capital which cannot be utilised for profitable purpose.
  • Medium term projects generates enough funds which enables their redemption.

Provisions of Companies Act, 2013 (Section 55):
1. No shares can be redeemed except (I) out of profits which are available for dividends or, (II) out of proceeds of fresh issue of shares made for redemption purpose.
Only fully paid shares can be redeemed.

2. If any premium has to be paid on redemption, it must be paid (I) out of company’s profit or (II) out of company’s share premium account. (Securities Premium)

3. If shares are redeemed out of profits, a sum equal to nominal value of shares redeemed must be transferred out of profits to Capital Redemption Reserve Account which would otherwise have been available for dividend.
Note: Its main objective is that with the repayment of redeemable preference shares, the creditors security should not be reduced.

5. Capital Redemption Reserve Account can be utilised only for paying unissued shares as fuily paid bonus shares.

6. According to Section 55 of Companies Act, 2013 a company cannot issue any preference share which is redeemable or irredeemable after expiry of 20 years from the date of its issue. A company may issue preference shares for a period exceeding 20 years but not exceeding 30 years for infrastructure projects (specified in Schedule VI) However, it is subject to redemption of minimum 10% of such preference shares per year from 21st year onwards or earlier, on proportionate basis, at the option of preference shareholders.

7. When the company redeems preference shares then it can issue shares upto the amount of nominal value of shares redeemed as if those shares have never been issued.

8. Redemption does not mean reduction of company’s authorised share capital.

9. Issue of new equity shares for the purpose of redemption does not mean increase of capital.

10. Non-compliance of above provisions leads to a default which is punishable with a fine extending to ? 10,000.

Methods of Redemption:

  • By proceeds of a fresh issue of shares
  • By capitalisation of undistributed profits
  • By combination of the above two

Redemption of Preference Shares by Fresh Issue of Shares:
1. Company can issue new shares i.e. equity or preference and proceeds are utilised for redemption.
Note: Proceeds from issue of debentures cannot be used for redemption.

2. If fresh issue is made at a premium: Only nominal value of shares issued should be considered for transferring amount to CRR A/c. Note: The amount of premium has to be transferred to Securities Premium A/c which can be utilised only for purposes mentioned u/s 52

3. if fresh issue is made at a discount – As per Companies Act 2013, fresh issue cannot be made on discount.

Advantages Disadvantages
(i) No cash outflow.
(ii) Shares can be valued at premium.
(iii) No capital gain tax.
(iv) Retention of equity interest by shareholders.
(i) Dilution of earnings.
(ii) Change in Shareholdings.

Journal Entries:
(I) When new shares are issued at par
Bank A/c Dr.
To Share Capital A/c

(II) When new shares are issued at a premium
Bank A/c Dr.
To Share Capital A/c To Securities Premium A/c

(III) Redemption at par
Redeemable Preference Share Capital A/c Dr.
To Preference Shareholders A/c

(IV) Redemption at premium
Redeemable Preference Share Capital A/c Dr.
Premium on Redemption A/c Dr.
To Preference Shareholders A/c

(V) When payment is made to Preference Shareholders
Preference Shareholders A/c Dr.
To Bank A/c

(Vi) Adjustment of Premium on Redemption
Profit and Loss A/c Dr.
Securities Premium A/c Dr.
To Premium on Redemption of Preference Shares A/c

Redemption of preference shares by capitalisation of undistributed profits:
In this case, an amount equal to the face value of shares redeemed is transferred to CRR A/c.

Advantages Disadvantages
(i) No change in shareholdings.
(ii) No dilution of earnings.
(i) Reduction in liquidity
(ii) Capital gain tax liability

Journal Entries:
(I) When Shares are redeemed at par
Redeemable Preference Share Capital A/c Dr.
To Preference Shareholders A/c

(II) When Shares are redeemed at Premium
Redeemable Preference Share Capital A/c Dr.
Premium on Redemption A/c Dr.
To Preference Shareholders A/c

(III) When payment is made to Preference Shareholders
Preference Shareholders A/c Dr.
To Bank A/c

(IV) Adjustment of Premium on Redemption
Profit and Loss A/c Dr.
Securities Premium A/c Dr.
To Premium on Redemption A/c

(V) Transferring nominal amount of shares redeemed to Capital
Redemption Reserve Account (CRR)
General Reserve A/c Dr.
Profit and Loss A/c Dr.
To CRR A/c

Redemption of Preference Shares by Combination of Fresh Issue and Capitalisation of Undistributed Profits
→ In this case,

→ Redeemable Pref. Share Capital
= CRR A/c + New Share Capital A/c

→ Amount to be transferred to CRR A/c
= Face value of shares redeemed – Proceeds from new issue.

→ Proceeds to be collected from New Issue
= Face value of shares redeemed – Profits available for distribution as dividend.

Introduction to Company Accounts-Redemption of Preference Shares MCQ Questions

1. According to Sec-55 of Companies Act, 2013, a company cannot redeem its preference shares out of:
(a) Revenue Profits
(b) Net proceeds of fresh issue of shares
(c) Partly out of revenue profits and partly out of net proceeds of fresh issue of shares
(d) Out of redemption of debentures
Answer:
(d) Out of redemption of debentures

2. Redeemable preference shares of ₹ 2,00,000 are redeemed at par for which purpose, fresh equity shares are issued for ₹ 80,000 at 10% premium.
The amount to be transferred to Capital Redemption Reserve will be:
(a) ₹ 80,000
(b) ₹ 1,20,000
(c) ₹ 2,00,000
(d) ₹ 1,12,000
Answer:
(b) ₹ 1,20,000

3. Which of the following accounts can be transferred to Capital Redemption Reserve A/c?
(a) General Reserve A/c
(b) Forfeited Share A/c
(c) Profit prior to incorporation
(d) Share Premium A/c
Answer:
(a) General Reserve A/c

4. Which of the following cannot be used for the purpose of creation of Capital Redemption Reserve A/c?
(a) Credit Balance of Profit/Loss Account
(b) General Reserve Account
(c) Dividend Equalisation Reserve Account
(d) Unclaimed Dividend Account
Answer:
(d) Unclaimed Dividend Account

5. If preference shares are redeemed at premium, such premium may be provided out of:
(a) Share Forfeited A/c
(b) Security Premium A/c
(c) Proceeds of fresh issue of shares
(d) CRR A/c
Answer:
(b) Security Premium A/c

6. S Ltd. issued 2000, 10% preference shares of ₹100 each at par, which are redeemable at a premium of 10%. For the purpose of redemption, the company issued 1,500 equity shares of ₹ 100 each at a premium of 10%. At the time of redemption of preference shares, the amount to be transferred by the company to CRR will be:
(a) ₹ 50,000
(b) ₹ 45,000
(c) ₹ 55,000
(d) ₹ 60,000
Answer:
(a) ₹ 50,000

7. T Ltd. issued 30,000 12% preference shares of ₹10 each at a premium of 5% which are redeemable at par. The company, since it did not have sufficient cash resources to redeem the preference shares, issued 20,000,14% debentures of 0 each at a premium of 10%. The amount to be transferred to CRR will be:
(a) ₹ 85,000
(b) ₹ 1,00,000
(c) ₹ 3,00,000
(d) ₹ 1,10,000
Answer:
(c) ₹ 3,00,000

8. Preference shares amounting to ₹ 2,50,000 are redeemed at a premium of 5% by issue of shares amounting to ₹ 1,50,000 at a premium of 10%. The amount to be transferred to CRR will be:
(a) ₹ 1,05,000
(b) ₹ 1,00,000
(c) ₹ 2,00,000
(d) ₹ 1,11,000
Answer:
(b) ₹ 1,00,000

9. The balance appearing in the books of company at the end of the year were: CRR A/c- ₹ 50,000, Security Premium ₹ 5,000 Revaluation Reserve – ₹ 2,000; P/L A/c (Dr.) 10,000, maximum amount available for distribution as bonus shares will be __________.
(a) ₹ 50,000
(b) ₹ 55,000
(c) ₹ 45,000
(d) ₹ 57,000
Answer:
(b) ₹ 55,000

10. Which of the following method cannot be used to redeem the preference shares?
(a) Capitalisation of undistributed profits
(b) Proceeds of fresh issue of shares
(c) Both (a) and (b)
(d) The proceeds from issue of debentures
Answer:
(d) The proceeds from issue of debentures

11. Which of the following statement is false?
(a) A company has to redeem its preference shares within 20 years.
(b) Preference Shareholders are creditors of the company.
(c) The part of authorised capital which can be called up only in the event of liquidation of a company is called reserve capital.
(d) Capital Redemption Reserve can be utilized only for issuing fully paid bonus shares.
Answer:
(c) The part of authorised capital which can be called up only in the event of liquidation of a company is called reserve capital.

12. On redemption of preference shares, money cannot be arranged (for payment to shareholders) from __________.
(a) issue of new shares
(b) sale of investment
(c) sale of fixed asset
(d) bank loan or overdraft
Answer:
(d) bank loan or overdraft

13. Share premium cannot be used to __________.
(a) issue bonus shares
(b) redeem preference shares
(c) write off preliminary expenses
(d) write off discount on issue of shares
Answer:
(b) redeem preference shares

14. Preference shares can be redeemed:
(a) Even if they are partly paid
(b) After getting permission from the court only
(c) Only if they are fully paid
(d) All of the above
Answer:
(c) Only if they are fully paid

15. The preference share which carry the right of participating jn the surplus left after paying the equity dividend are called:
(a) Convertible Preference Shares
(b) Cumulative Preference Shares
(c) Participating Preference Shares
(d) All of the above
Answer:
(c) Participating Preference Shares

16. Redeemable preference shares must be redeemed within:
(a) 5 years
(b) 20 years
(c) 15 years
(d) 10 years
Answer:
(b) 20 years

17. Irredeemable preference shares:
(a) Cannot be issued at all
(b) Can be issued only after taking permission from the ROC
(c) Can be issued after taking approval of the Central Government
(d) Can be issued after obtaining the permission of the court
Answer:
(a) Cannot be issued at all

18. ₹ 10,00,000 preference shares are to be redeemed by issue of 8,000 equity shares @ ₹ 100 each for ₹ 120 each. Then, the Capital Redemption Reserve is to be credit by:
(a) ₹ 4,00,000
(b) ₹ 10,00,000
(c) ₹ 8,00,000
(d) ₹ 2,00,000
Answer:
(d) ₹ 2,00,000

19. Preference shares can be redeemed from:
(a) Out of profits
(b) Proceeds of fresh issue of equity shares
(c) Proceeds of fresh issue of preference shares
(d) All of the above
Answer:
(d) All of the above

20. If the preference shares are redeemed at a premium, then the premium payable on redemption is provided out of:
(a) Securities Premium Account
(b) Profits of the Company
(c) Both (a) and (b)
(d) Neither (a) nor (b)
Answer:
(c) Both (a) and (b)

21. When the shares are redeemed out of profits then an amount equal to the nominal value of such shares is transferred to:
(a) General Reserve
(b) Capital Redemption Reserve
(c) Capital Reserve
(d) Securities Premium
Answer:
(b) Capital Redemption Reserve

22. The maximum fine which can be charged on the company or its members for non compliance of section 55 is:
(a) ₹ 1,00,000
(b) ₹ 10,000
(c) ₹ 5,000
(d) ₹ 25,000
Answer:
(b) ₹ 10,000

23. Which of the following statement is false?
(a) Capital Redemption Reserve can be applied for issuing bonus shares of the company
(b) Partly paid up shares can be redeemed
(c) Both (a) and (b)
(d) Neither (a) nor (b)
Answer:
(b) Partly paid up shares can be redeemed

24. A company cannot issue redeemable preference shares for a period exceeding:
(a) 6 Years
(b) ₹ Years
(c) 8 Years
(d) 20 Years.
Answer:
(d) 20 Years.
According to Sec 55 of Companies Act, 2013 a company cannot issue any preference share, which is irredeemable or is redeemable after the expiry of a period of twenty years from the date of its issue.

25. Solid Ltd. issued 2,000, 10% preference shares of ₹ 100 each at par, which are redeemable at a premium of 10%. For the purpose of redemption, the company issued 1,500 equity shares of ₹ 100 each at a premium of 20% per share. At the time of redemption of preference shares, the amount to be transferred by the company to the Capital Redemption Reserve Account will be __________.
(a) ₹ 50,000
(b) ₹ 40,000
(c) ₹ 2,00,000
(d) ₹ 2,20,000
Answer:
(a) ₹ 50,000
Amount to be transferred to Capital Redemption Reserve:
Introduction to Company Accounts-Redemption of Preference Shares – CS Foundation Fundamentals of Accounting Notes 1
Thus, amount of Capital Redemption Reserve Account will be ₹ 50,000.

26. Which of the following accounts can not be transferred to capital redemption reserve account?
(a) Dividend equalisation account
(b) General reserves
(c) Profit and loss appropriation account.
(d) Securities premium reserves.
Answer:
(d) Securities premium reserves.
Whenever the redemption or buy-back of shares is made out of the profits of the company, a sum equal to the nominal amount of the shares to be redeemed, shall be transferred to a reserve called the Capital Redemption Reserve Account. For this purpose, following accounts are used:

  • General Reserves
  • Profit & Loss Appropriation A/c
  • Dividend Equalization A/c
  • Other free Reserves

Hence, Securities premium reserves cannot be transferred.

27. Which of the following cannot be utilized for redemption of preference share?
(a) General Reserve
(b) Capital Reserve
(c) Credit balance of profit and loss account
(d) Dividend equalisation account.
Answer:
(b) Capital Reserve
At the time of redemption of Preference Shares, capital redemption reserve is to be created. Since it is a capital reserve, it can be created only out of revenue profits. Hence, capital reserve cannot be used for redemption of preference share.

28. Solid Ltd. issued 2000, 10% preference shares of ₹ 100 each at par, which are redeemable at a premium of 10% for the purpose of redemption the company issued 1500 equity shares of ₹ 100 each at a premium of 20% per share. At the time of redemption of preference shares, the amount to be transferred by the company to the capital redemption reserve account will be __________.
(a) ₹ 50,000
(b) ₹ 2,20,000
(c) ₹ 2,00,000
(d) ₹ 40,000
Answer:
(a) ₹ 50,000
If the redeemable preference share are redeemed partly out of profits of company and partly out of fresh issue of shares equity or preference. Then Capital Redemption Reserve Account is created with the amount of difference between share capital redeemed and share capital account.
Capital Redemption Reserve = 2,000 x 100/-
Preference Share – 1500 x 100/- New equity share
Capital Redemption Reserve = 2,00,000 – 1,50,000
= ₹ 50,000

29. Capital Redemption Reserve A/c is prepared when __________.
(a) Redemption is done out of issue of fresh shares
(b) Redemption is done out of profit of the company
(c) Redemption is done through company’s capital fund
(d) All of the above
Answer:
(b) Redemption is done out of profit of the company
Whenever a company redeems its preference shares. Then the nominal value or face value of the shares is put into capital redemption reserve fund. It is transferred from the undistributed profits i.e. general reserve, profit or loss account.

30. During the year 2008-2009. Tin Ltd. issued 20,000, 12% preference shares of ₹ 10 each at a premium of 5%, which are redeemable after 4 years at par. During the year 2012-2013, as the company did not have sufficient cash resources to redeem the preference shares, it issued 10,000, 14% preference shares of ₹ 10 each at a premium of 10%. At the time of redemption of 12% preference shares, the amount to be transferred to capital redemption reserve would be:
(a) ₹ 2,00,000
(b) ₹ 1,10,000
(c) ₹ 90,000
(d) ₹ 1,00,000
Answer:
(d) ₹ 1,00,000
When preference shares are to be redeemed out of profit, a sum equal to the nominal value of shares redeemed out of profit shall be transferred to Capital Redemption Reserve A/c.

31. A company cannot issue redeemable preference shares for a period exceeding __________.
(a) 6 years
(b) 7 years
(c) 8 years
(d) 20 years
Answer:
(d) 20 years
A company cannot issue redeemable preference shares for a period exceeding 20 years and for infrastructure projects, redeemable preference shares issued for 25 to 30 years.

32. S Ltd. issued 8,000,10% preference shares of ₹ 100 each at par which is redeemable at premium of 10% company issued 1500 equity shares of ₹ 100 each @ 20% premium per share. The amount transferred by company to CRR A/c will be.
(a) ₹ 1,50,000
(b) ₹ 2,00,000
(c) ₹ 2,50,000
(d) None of the above
Answer:
(a) ₹ 1,50,000
If preference shares are proposed to be redeemed out of the profits of the company, a sum equal to the nominal amount of shares to be redeemed shall be transferred to a reserve called Capital Redemption Reserve. In following question; company issued 1500 equity shares at premium amount of ₹ 100 per each with 20% premium respectively.
Nominal value of share: 1500 x 100 = ₹ 1,50,000, Thus, option (a) is correct.

33. Solid Ltd. issued 2,000, 10% preference shares of ₹ 100 each at par, which are redeemable at a premium of 10%, for the purpose of redemption, the company issued 1,500 equity shares of ₹ 100 each at a premium of 20% per share. At the time of redemption of preference shares, the amount to be transferred by the company to the capital Redemption Reserve Account will be:
(a) ₹ 50,000
(b) ₹ 40,000
(c) ₹ 2,00,000
(d) ₹ 2,20,000
Answer:
(a) ₹ 50,000
At the time of redemption of preference shares, replacement of capital to be effected is equal to the nominal value of preference shares redeemed.
Nominal Value of Equity Issue = 1500 x 100
= 1,50,000
∴ CRR to be created is ₹ 50,000

34. Preference shares cannot be redeemed after?
(a) 10 years
(b) 20 years
(c) 50 years
(d) 5 years
Answer:
(b) 20 years
A company may issue preference shares which are liable to be redeemed within a period not exceeding twenty years from the date of their issue under section 55 of the Companies Act, 2013. The company should be authorized by its articles.

35. ‘A’ company purchase land for ₹ 1,00,000 and paid debenture of ₹ 10 each at 10% premium. Find number of debenture issued?
(a) 50,000
(b) 5,000
(c) 10,000
(d) None
Answer:
(b) 5,000
Introduction to Company Accounts-Redemption of Preference Shares – CS Foundation Fundamentals of Accounting Notes 2

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